Recent years have seen prominent calls for quality improvement within the health-care sector. Nevertheless, the social value of quality turns on its benefits and costs. The purpose of this two-year research project is to investigate the quality of hospitals as perceived by Medicare patients, the cost of perceived quality, and their relation to existing measures. The study will enhance our understanding of the quality and cost of hospital care for Medicare beneficiaries and the broader population. Understanding hospital quality and costs is challenging for at least two reasons. First, hospital quality is multifaceted and difficult to measure. Second, hospitals that are well-managed from the perspective of costs (that is, more productive) may also tend to be higher quality. For both of these reasons, a comparison of existing quality measures to costs across hospitals might tend to understate the actual cost of quality improvement. A possible solution to these problems appeals to hospital patients themselves. Patients possess some information about hospitals from family and friends, physicians, "report cards," or even hospitals themselves. Insofar as a patient exercises choice among hospitals, her perceptions about hospital quality are revealed by her choice to receive care at a particular hospital. Perceived quality is complementary to existing measures of clinical quality. From an economic perspective, quality includes all aspects of the hospital experience that patients value, including "hotel" amenities as well as clinical quality. We propose to infer perceived quality from the hospital choices of Medicare patients receiving coronary and pneumonia care, as reported in hospital discharge abstracts from California's Office of Statewide Health Planning and Development. We will specify and estimate a discrete-choice model of hospital choice that accounts for patients'perceptions about quality with a hospital-level fixed effect. In this model a patient trades off a hospital's quality with its proximity to home, and tastes may vary with age, health, and other factors. We will then incorporate the estimates of perceived quality into a translog model of hospital costs and analyze these costs over time. Within the cost model, we are concerned that a hospital's quality may be related to its unobserved productivity. We argue that a hospital's competitive rationale for quality varies with the tastes of patients residing near the hospital;we further argue that patients do not choose where to live based on hospital productivity. We will therefore instrument for each hospital's quality with a measure, derived directly from the analysis of hospital choice, of the taste for quality among neighboring patients. After estimating perceived quality and its cost, we will compare our results to quality and its cost based on alternative measures of clinical quality and the patient experience. PUBLIC HEALTH RELEVANCE: The quality and cost of hospital care is a major public-health concern in the United States. This project proposes to infer the quality of hospitals as perceived by Medicare patients, to measure the cost of perceived quality, and to compare the results to quality and its cost based on alternative measures of clinical quality and the patient experience.